Trading volatility is nothing new for option traders. Most option traders rely heavily on volatility information to choose their trades. For this reason, the Chicago Board Options Exchange (CBOE) Volatility Index, more commonly known by its ticker symbol VIX, has been a popular trading tool for option and equity traders since its introduction in 1993. Until recently, traders used regular equity or index options to trade volatility, but many quickly realized that this was not the best method. On Feb. 24, 2006, the CBOE rolled out options on the VIX, giving investors a direct and effective way to use volatility. In this article, we take a look at the past performance of the VIX and discuss the advantages offered by the VIX options.
What Is the VIX?
The VIX is an implied volatility index that measures the market's expectation of 30-day S&P 500 volatility implicit in the prices of near-term S&P options. VIX options give traders a way to trade volatility without having to factor in the price changes of the underlying instrument, dividends, interest rates or time to expiration - factors that affect volatility trades using regular equity or index options. VIX options allow traders to focus almost exclusively on trading volatility.
Traders have found the VIX very useful in trading, but now it provides superb opportunities for both hedging and speculation. It may also be an excellent tool in the quest for portfolio diversification. Diversification, which most people consider a good thing, is useful only if the instruments used are not correlated. In other words, if you own 10 stocks and they tend to move together, then you really aren't diversified at all. One advantage of the VIX is its negative correlation with the S&P 500. According to the CBOE's own website, since 1990 the VIX has moved opposite the S&P 500 Index (SPX) 88% of the time. On average, VIX has risen 16.8% on days when SPX fell 3% or more. This makes it an excellent...
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